Guide to Stock Options and Journal Entries
Compensatory stock options are a valuable form of compensation offered to employees, allowing them to purchase company stock at a price below market value, after a certain period (vesting period). Offering stock options is a great tool to motivate employees, but proper accounting for them is essential to ensuring financial transparency.
This guide will help you understand how to record stock option expenses and journal entries when stock options are exercised.
Understanding Compensatory Stock Options
Compensatory stock options are a form of equity compensation where companies grant employees the right to purchase a specified number of shares of company stock at a specified price, known as the exercise price. The exercise price is usually less than the market value, providing a benefit to employees who choose to exercise their options.
There are two key stages to understand:
- Grant Date: When the company grants stock options to employees.
- Exercise Date: When employees exercise their options, purchasing the stock at the predetermined price.
Recording Stock Option Expenses (Grant Date)
When stock options are granted, companies must recognize the related compensation expense over the service or vesting period. This is the period in which services must be rendered before employees can exercise their options.
Journal Entry for Stock Option Expense (Yearly)
Each year during the vesting period, you’ll record the stock compensation expense. The entry for the yearly expense looks like this:
| Date | Account | Debit ($) | Credit ($) |
|---|---|---|---|
| X/XX/XXXX | Stock Compensation Expense A/c Debit | XX | |
| To Additional Paid-in Capital (APIC) A/c | XX |
This journal entry increases your expenses and equity through the APIC account. During the vesting period, the total cost will match the total compensation cost calculated on the date of grant.
Accounting for Stock Option Exercise
Once the employee decides to exercise their options, you will need to record the appropriate journal entries. The exercise of stock options involves two main steps: receiving cash from the employee and adjusting the equity account.
Journal Entry When Stock Options Are Exercised
Here’s how to record the journal entry:
- Record the Cash Received: The company receives cash from the employee for the shares purchased at the exercise price.
- Record the Fair Market Value (FMV) of Stock Options: Adjust the equity accounts for the difference between the FMV of the stock and the exercise price.
The full journal entry looks like this:
| Date | Account | Debit ($) | Credit ($) |
|---|---|---|---|
| X/XX/XXXX | Bank A/c Debit | XX | |
| Additional Paid-in Capital (APIC) – Stock Options A/c Debit | XX | ||
| To Common Stock (at Par) A/c | XX | ||
| To Additional Paid-in Capital (APIC) A/c | XX |
Explanation:
- Bank: Debit for the amount received from the employee (shares x exercise price).
- APIC – Stock Options: Debit the fair market value of the stock options.
- Common Stock: Credit for the par value of the stock.
- APIC: Credit the remainder to reflect the difference between the exercise price and FMV.
Example: Journal Entry for Stock Option Exercise
Let’s say an employee exercises 1,000 stock options with the following details:
- Exercise Price: $50 per share
- Fair Market Value (FMV): $70 per share
- Par Value of Stock: $1 per share
The employee pays $50,000 (1,000 shares x $50), but the market value of the stock is $70,000 (1,000 shares x $70). The journal entry would be:
| Date | Account | Debit ($) | Credit ($) |
|---|---|---|---|
| X/XX/XXXX | Bank A/c Debit | 50,000 | |
| APIC – Stock Options A/c Debit | 70,000 | ||
| To Common Stock (at Par) A/c | 1,000 | ||
| To APIC A/c | 119,000 |
Why Proper Stock Option Accounting Matters
- Transparency: Recording stock options provides transparency into your company’s compensation practices and liabilities.
- Compliance: It ensures compliance with accounting standards such as ASC 718 (Stock Compensation) and IFRS 2.
- Investor Trust: Investors have a keen interest in how stock options are exercised, as they directly affect a company’s profitability.
Key Takeaways:
- Recognize Stock Compensation Over Time: Spread the expense over the vesting period, ensuring that compensation is accounted for in the proper periods.
- Track Fair Market Value (FMV): Calculate the FMV of stock options to determine the total compensation expense.
- Exercise Journal Entries: When options are exercised, ensure that cash received, par value, and additional paid-in capital are recorded appropriately.
- Be Compliant: Adhere to accounting standards such as ASC 718 and IFRS 2 when handling stock-based compensation.
By following these steps, you will maintain accurate and transparent records of stock options and ensure compliance with all accounting standards.
Final Thought:
Stock options can be a valuable tool to motivate employees, but they must be properly managed in your accounting system. Proper journal entries ensure that your financial statements reflect the correct cost of this type of compensation